Flexing China makes for a cheery outlook

Yet more terrific news for the Australian economy, this time with conformation that the pace of economic expansion in China is picking up from the slowdown that reached a low point around the middle of the year.

The trifecta of economic news from China was in the form of better than expected results for industrial production, fixed asset investment and retail sales. This good news is consistent with a rate of GDP growth around 7.5 to 8 per cent rather than the sub-7 per cent that was feared a few months ago as the data turned sour.

Recall that China is in the second largest economy in the world behind only the US and it takes around one third of Australia’s exports. Chinese economic news is more important to Australia than from anywhere else (Can Abbott crack China's FTA challenge?, September 11).

In terms of the specifics, industrial production rose by 10.4 per cent in the year to August, up from July’s 9.7 per cent and above the 9.9 per cent consensus estimate. This was the fastest rate of increase in 17 months. Fixed asset investment rose 20.3 per cent over the year, up from 20.1 per cent in the prior month, while retail sales lifted 13.4 per cent through the year to be above the 13.2 per cent growth rate recorded in the year to July.

Commonwealth Bank of Australia senior economist Andy Ji saw the data as so positive that there is upside to the the bank's current forecast for 7.6 per cent GDP growth in 2013.

The news follows the better-than-expected international trade data and confirmation that inflation in China was still well-contained, which would allow the authorities to hold policy at an easier setting for a little longer, thereby locking in a solid rate of expansion for the remainder of 2013 and into 2014.

In last month’s Reserve Bank of Australia Statement on Monetary Policy, released days after it cut official interest rates to a record low 2.5 per cent, the bank noted that “growth in China is now unlikely to pick up much, if at all, in coming quarters. Rather, it is expected to remain at a pace that is close to the official target [of 7 per cent]”.

Clearly a lot can change in five weeks, and it is nice at last to see the surprises coming on the high side after several years of growth downgrades. The recent trends in China will no doubt see the Reserve Bank move quickly to recast its forecast for Australia's growth and terms of trade higher, and in doing so scaling back the forecast rise in the unemployment rate.

This news from China creates a new foundation for an upbeat outlook for the Australian dollar. It also means that the start of the fresh interest rate hiking cycles could be quite soon and the extent of those rate hikes much greater than just about anyone is currently anticipating.

The Aussie dollar jumped on the better news and there was also a lift in the stock market trends that spread to Europe and the US overnight. This morning the dollar is trading at US 93.15 cents, while US stocks rose around 0.75 per cent. Bond yields also moved higher. Rising stocks, bond yields and an appreciating Australian dollar are all signs of a favourable growth outlook with some upside risks to global inflation. 

Of course, there are risks ahead, as there always are in economics and financial markets. In China, there remains a perception that there is considerable excess capacity and that the shadow banking systems is sufficiently fragile that a property free-fall is being factored into some scenarios for 2014. Indeed, this looks to be the biggest risk for the Chinese economy. 

There is also the heavily intertwined risk where China’s largest buyer of manufactured goods, the eurozone, remains stuck in economic quicksand even though the run of recent news has been a little less down beat. If the hints of better news from the eurozone in recent months fade, the current round of good news from China may quickly reverse.

For now, with policy settings tilted towards growth and a recovery in export demand from slowly recovering western countries, China seems well placed to grow at a solid clip over the next 18 months and Australia once again will hang on for the ride.